NOT FILED WITH THE SEC 10-Q... · 2020. 10. 13. · not filed with the sec this quarterly report is...

NOT FILED WITH THE SEC

THIS QUARTERLY REPORT IS BEING PREPARED PURSUANT TO REQUIREMENTS CONTAINED IN THE INDENTURE DATED AS OF AUGUST 8, 2017 GOVERNING THE 6.750% SENIOR NOTES DUE 2025 ISSUED BY ASHTON WOODS USA L.L.C, IN THE INDENTURE DATED AS OF MARCH 27, 2019

GOVERNING THE 9.875% SENIOR NOTES DUE 2027 ISSUED BY ASHTON WOODS USA L.L.C., AND IN THE INDENTURE DATED AS OF JANUARY 23, 2020 GOVERNING THE 6.625% SENIOR NOTES DUE 2028 ISSUED BY ASHTON WOODS USA L.L.C..

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2020 OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission file Number: N/A

Ashton Woods USA L.L.C.(Exact Name of Registrant as Specified in Its Charter)

Nevada 37-1590746(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification No.)

3820 Mansell Road, Suite 400 Alpharetta, GA 30022

(Address of Principal Executive Offices) (Zip Code)(770) 998-9663

Registrant's telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Title of Each Class Title of Each ClassNONE NONE

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ ] No [ ] N/A [X] Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ] N/A [X] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer, “accelerated filer”, “small reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer [ ]

Accelerated filer [ ]

Non-accelerated filer [X]

Smaller reporting company [ ]

Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

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ASHTON WOODS USA L.L.C.INDEX TO FORM 10-Q

PAGEPART I. FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

Review Report of Independent Auditors 3Unaudited Condensed Consolidated Balance Sheets 4Unaudited Condensed Consolidated Statements of Income 5Unaudited Condensed Consolidated Statements of Changes in Members' Equity 6

Unaudited Condensed Consolidated Statements of Cash Flows 7Notes to Unaudited Condensed Consolidated Financial Statements 9

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 29

Item 3. Quantitative and Qualitative disclosures about market risk 47

Item 4. Controls and Procedures 47

PART II. OTHER INFORMATION

Item 1. Legal Proceedings 48

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A member firm of Ernst & Young Global Limited

Ernst & Young LLP55 Ivan Allen Jr BlvdSuite 1000Atlanta, GA 30308

Tel: +1 404 817 4241Fax: +1 404 436 9829ey.com

Review Report of Independent Auditors

The Members of Ashton Woods USA L.L.C.

We have reviewed the condensed consolidated financial information of Ashton Woods USA L.L.C., whichcomprise the condensed consolidated balance sheet as of August 31, 2020, and the related condensedconsolidated statements of income and cash flows for the three-month periods ended August 31, 2020 and2019, and the condensed consolidated statements of changes in members’ equity for each of the three-monthperiods in the period from May 31, 2019 to August 31, 2020.

Management’s Responsibility for the Financial Information

Management is responsible for the preparation and fair presentation of the condensed financial information inconformity with U.S. generally accepted accounting principles; this includes the design, implementation, andmaintenance of internal control sufficient to provide a reasonable basis for the preparation and fair presentationof interim financial information in conformity with U.S. generally accepted accounting principles.

Auditor’s Responsibility

Our responsibility is to conduct our review in accordance with auditing standards generally accepted in theUnited States applicable to reviews of interim financial information. A review of interim financial informationconsists principally of applying analytical procedures and making inquiries of persons responsible for financialand accounting matters. It is substantially less in scope than an audit conducted in accordance with auditingstandards generally accepted in the United States, the objective of which is the expression of an opinionregarding the financial information. Accordingly, we do not express such an opinion.

Conclusion

Based on our review, we are not aware of any material modifications that should be made to the condensedconsolidated financial information referred to above for it to be in conformity with U.S. generally acceptedaccounting principles.

Report on Condensed Consolidated Balance Sheet as of May 31, 2020

We have previously audited, in accordance with auditing standards generally accepted in the United States, theconsolidated balance sheet of Ashton Woods USA L.L.C. as of May 31, 2020, and the related consolidatedstatements of income, changes in members’ equity, and cash flows for the year then ended (not presentedherein); and we expressed an unmodified audit opinion on those audited consolidated financial statements inour report dated July 15, 2020. In our opinion, the accompanying condensed consolidated balance sheet ofAshton Woods USA L.L.C. as of May 31, 2020, is consistent, in all material respects, with the consolidatedbalance sheet from which it has been derived.

October 13, 2020

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Anni GaoTypewriter

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ASHTON WOODS USA L.L.C.UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

August 31,2020

May 31,2020

Assets:Cash and cash equivalents $ 246,674 $ 255,314 Restricted cash 1,102 3,059 Receivables 34,843 33,683 Inventory 905,168 882,002 Property and equipment, net 10,667 11,217 Investments in unconsolidated entities 3,486 4,608 Deposits on real estate under option or contract 151,985 143,989 Other assets 120,483 118,373

Total assets $ 1,474,408 $ 1,452,245

Liabilities and members’ equity:Liabilities:

Accounts payable $ 93,096 $ 70,447 Other liabilities 147,109 167,375 Customer deposits 23,654 17,580 Debt 746,301 746,395

Total liabilities 1,010,160 1,001,797 Commitments and contingencies (Note 12)Members' equity: 464,248 450,448

Total liabilities and members' equity $ 1,474,408 $ 1,452,245

See accompanying notes to unaudited condensed consolidated financial statements.

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ASHTON WOODS USA L.L.C.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands)

Three months ended August 31,

2020 2019(Unaudited)

Revenues:Home sales $ 413,826 $ 363,434 Land sales 65 — Financial services and other revenues 9,591 6,735

423,482 370,169

Cost of sales:Cost of sales homes 335,286 305,176 Cost of sales land 74 28 Cost of sales financial services and other revenues 7,203 4,407

342,563 309,611

Gross profit 80,919 60,558

Other expense (income):Selling, general and administrative 55,287 53,797 Interest expense 7,429 2,776 Depreciation and amortization 2,182 2,352 Other income (230) (562)

64,668 58,363 Equity in earnings of unconsolidated entities 1,499 968

Net income $ 17,750 $ 3,163


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ASHTON WOODS USA L.L.C.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

MEMBERS' EQUITY (In thousands)

Class A interest

Class B interests

Class C interests

Total members'

equityMembers' equity at May 31, 2019 (Audited) $ 144,455 $ 31,781 $ 210,861 $ 387,097 Net income 1,231 302 1,630 3,163 Distributions (2,704) (665) (3,581) (6,950) Members' equity at August 31, 2019 (Unaudited) $ 142,982 $ 31,418 $ 208,910 $ 383,310 Net income 5,035 1,237 6,667 12,939 Distributions (628) (155) (832) (1,615) Members' equity at November 30, 2019 (Unaudited) $ 147,389 $ 32,500 $ 214,745 $ 394,634 Net income 5,710 1,403 7,561 14,674 Distributions (1,518) (373) (2,009) (3,900) Members' equity at February 28, 2020 (Unaudited) $ 151,581 $ 33,530 $ 220,297 $ 405,408 Net income 17,525 4,310 23,205 45,040 Members' equity at May 31, 2020 (Audited) $ 169,106 $ 37,840 $ 243,502 $ 450,448 Net income 6,907 1,698 9,145 17,750 Distributions (1,537) (378) (2,035) (3,950) Members' equity at August 31, 2020 (Unaudited) $ 174,476 $ 39,160 $ 250,612 $ 464,248


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ASHTON WOODS USA L.L.C.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


2020 2019(Unaudited)

Cash flows from operating activities:Net income $ 17,750 $ 3,163

Adjustments to reconcile net income to net cash used in operating activities: Equity in earnings of unconsolidated entities (1,499) (968) Returns on investments in unconsolidated entities 2,448 1,759 Long-term compensation expense 1,820 998

Inventory impairments 25 407 Depreciation and amortization 2,182 2,352 Changes in operating assets and liabilities: Inventory (23,068) (53,915) Receivables (1,160) (7,620) Deposits on real estate under option or contract (7,996) (2,385) Other assets (3,167) 6,759 Accounts payable 22,649 (6,359) Other liabilities (20,917) (22,514) Customer deposits 6,074 3,030 Net cash used in operating activities (4,859) (75,293) Cash flows from investing activities: Returns of investments in unconsolidated entities — 1,372 Additions to property and equipment (1,732) (2,280) Net cash used in investing activities (1,732) (908) Cash flows from financing activities: Borrowings from revolving credit facility — 299,700 Repayments of revolving credit facility — (214,999) Payment of debt issuance costs (56) (1,700) Members' distributions (3,950) (6,950) Net cash (used in) provided by financing activities (4,006) 76,051 Change in cash, cash equivalents, and restricted cash (10,597) (150) Cash, cash equivalents, and restricted cash, beginning of period 258,373 189 Cash, cash equivalents, and restricted cash, end of period $ 247,776 $ 39 Supplemental cash flow information: Cash paid for interest, net of amounts capitalized $ 6,835 $ 1,862

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ASHTON WOODS USA L.L.C.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(continued)(In thousands)

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the unaudited condensed consolidated balance sheets to the total of the same such amounts shown above:

As of August 31,2020 2019

Cash and cash equivalents $ 246,674 $ — Restricted cash 1,102 39 Total cash, cash equivalents, and restricted cash $ 247,776 $ 39

Supplemental disclosures of cash flows information:


2020 2019Right-of-use assets obtained in exchange for new operating lease liabilities $ 52 $ —


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ASHTON WOODS USA L.L.C.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

August 31, 2020

Note 1 — Basis of Presentation and Significant Accounting Policies

(a) Operations

Ashton Woods USA L.L.C. (the “Company” or “Ashton Woods”), operating as Ashton Woods Homes, is a limited liability company that designs, builds, and markets detached and attached single-family homes under the Ashton Woods Homes and Starlight Homes brand names. The Company offers entry-level, move-up, and multi-move-up homes under the Ashton Woods Homes brand name and offers entry-level homes under the Starlight Homes brand name. As of August 31, 2020, the Company has Ashton Woods and Starlight Homes operations in the following markets:

East: Raleigh, Charleston, Atlanta, Orlando, and Southwest Florida (Tampa, Sarasota, and Naples)Central: Houston, Dallas, Austin, San Antonio, and Phoenix

The Company also offers title services to its homebuyers in its Austin, Dallas, Houston, San Antonio, Charleston, Raleigh, Orlando, Southwest Florida, and Atlanta operating divisions through two wholly-owned title agencies.

In addition, the Company offers residential mortgage services to its homebuyers and the public at large in Austin, Dallas, Houston, San Antonio, Charleston, Raleigh, Orlando, Phoenix, and Southwest Florida through an unconsolidated mortgage joint venture. The Company has an ownership interest of 49% in this mortgage joint venture.

(b) Basis of presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned, majority-owned, and controlled subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. In the Company's opinion, all adjustments (consisting solely of normal recurring accruals) necessary for a fair presentation of the results for the interim periods presented have been included in the accompanying unaudited condensed consolidated financial statements.

(c) Cash, cash equivalents, and restricted cash

The Company considers all highly liquid investments with an initial maturity of three months or less when purchased to be cash equivalents. Restricted cash consists of amounts held in restricted accounts as collateral for letters of credit issued and outstanding, as permitted by the Company's senior secured revolving credit facility, and other investments.

(d) Inventory

In addition to the costs of direct land acquisition, land development and home construction, inventory costs include interest, real estate taxes, and indirect overhead costs incurred during development and home construction. The Company uses the specific identification method for the purpose of accumulating home construction costs. Cost of sales for homes closed includes the specific construction costs of each home (both incurred and estimated to be incurred) and all applicable land acquisition, land development, and related costs based upon the total number of homes expected to be closed in each community. Any changes to the estimated total development costs subsequent to the initial home closings in a community are allocated to the remaining homes in the community.

When a home is closed, the Company generally has not yet recorded all incurred costs necessary to complete the home. Each month, the Company records as a liability and a charge to cost of sales the amount it estimates will ultimately be paid related to completed homes that have been closed as of the end of that month. The Company compares its updated home construction budgets to actual recorded costs to estimate the additional costs remaining to be paid on each closed home. The Company monitors the accuracy of each month’s accrual by comparing actual

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costs paid on closed homes in subsequent months to the amount accrued. Actual costs to be paid on closed homes in the future could differ from the current estimate.

Inventory is stated at cost, unless the carrying amount is determined not to be recoverable, in which case the inventory is written down to fair value in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 360-10, Property, Plant and Equipment (“ASC 360-10”). The Company reviews its inventory in accordance with ASC Subtopic 360-10, which requires long-lived assets to be assessed for impairment when facts and circumstances indicate an impairment may exist. The Company utilizes an undiscounted future cash flow model in this assessment. When the results of the undiscounted future cash flows are less than the carrying value of the community (asset group), an asset impairment must be recognized in the consolidated financial statements as a component of cost of sales. The amount of the impairment is calculated by subtracting the estimated fair value of the community, less cost to sell, from the carrying value. ASC Subtopic 360-10 also requires that assets held for sale be stated at the lower of cost or fair value, as determined based on active negotiations with market participants, less costs to sell. Accordingly, land held for sale is stated at the lower of accumulated cost or fair value less costs to sell.

Based on the Company's review of its inventory for impairment during the three months ended August 31, 2020, inventory impairment charges totaling $24.6 thousand were recognized. The inventory impairment charges consisted of impairments on homes in inventory, which is included as a component of cost of sales – homes in the unaudited condensed consolidated statements of income. The Company recorded inventory impairment charges of $0.4 million during the three months ended August 31, 2019, which consisted of $384.3 thousand of impairments on homes in inventory, which is included as a component of cost of sales – homes in the unaudited condensed consolidated statements of income, and $23.8 thousand of impairments of land that was held for sale, which is included as a component of cost of sales – land in the unaudited condensed consolidated statements of income.

In order for management to assess the fair value of its real estate assets, certain assumptions must be made that are highly subjective and susceptible to change. Management evaluates, among other things, the actual gross margins for homes closed and the gross margins for homes sold in backlog (representing the number or value of sales that have not yet closed, net of cancellations). This evaluation also includes assumptions with respect to future home sales prices, cost of sales, including levels of sales incentives, the monthly rate of sales, discount rates, profit margins, and potential buyers, which are critical in determining the fair value of the Company’s real estate assets. Given the historical variability in the homebuilding industry cycle and the current impacts and uncertainties of COVID-19, the Company is of the view that the valuation of homebuilding inventories is sensitive to changes in economic conditions, such as interest rates, the availability of credit, and unemployment levels. Changes in these economic conditions could materially affect the projected home sales prices, the level of sales incentives, the costs to develop land and construct homes, and the monthly rate of sales. Because of these potential changes in economic and market conditions, in conjunction with the assumptions and estimates required of management in valuing homebuilding inventory, actual results could differ materially from management’s assumptions and may require material inventory impairments to be recorded in the future.

(e) Receivables

Receivables at August 31, 2020 and May 31, 2020 consisted of the following (in thousands):

August 31,2020

May 31,2020

Closing funds due $ 4,762 $ 6,373 Land development receivables 16,036 13,957 MUD receivables (1) 9,759 10,280 Other receivables (2) 4,286 3,073

$ 34,843 $ 33,683

(1) Includes certain land development costs to be reimbursed by four Municipal Utility Districts in Houston, Texas.(2) Includes amounts due from utility companies, insurance companies, refundable deposits, and drawn amounts due from

salespersons.

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(f) Real estate not owned

Real estate not owned reflects the future purchase price of lots under option purchase agreements pursuant to ASC 606, Revenue From Contracts With Customers (“ASC 606”), ASC Subtopic 470-40 (“ASC 470-40”), Product Financing Arrangements, or ASC 810, Consolidation (“ASC 810”) (see Note 4).

(g) Investments in unconsolidated entities

The Company participates in one land development joint venture in which it has less than a controlling interest. The Company accounts for its interest in this entity under the equity method. The Company’s share of profits from lots it purchases from this joint venture is deferred and treated as a reduction of the cost basis of land purchased from the entity.

The Company offers residential mortgage services to its homebuyers and the public at large in Austin, Dallas, Houston, San Antonio, Charleston, Raleigh, Orlando, Phoenix, and Southwest Florida through an unconsolidated mortgage joint venture. The Company has an ownership interest of 49% in this mortgage joint venture. The Company’s investment in this mortgage joint venture is accounted for under the equity method.

Investments in unconsolidated entities are evaluated for other-than-temporary impairment during each reporting period pursuant to ASC Subtopic 323-10, Investments—Equity Method and Joint Ventures. A series of operating losses or other factors may indicate an other-than-temporary decrease in the value of the Company’s investment in the unconsolidated entity. The amount of impairment recognized is the excess of the investment’s carrying value over its estimated fair value. The Company did not recognize any other-than-temporary impairments during the three months ended August 31, 2020 and 2019 related to its investments in unconsolidated entities.

(h) Deposits and pre-acquisition costs

Deposits and pre-acquisition costs related to purchase agreements are capitalized when paid and classified in the unaudited condensed consolidated balance sheets as deposits on real estate under option or contract (for deposits) and other assets (for pre-acquisition costs) until the related land is acquired. These costs are transferred to inventory at the time the land or lots are acquired. Nonrefundable deposits and pre-acquisition costs are charged to expense when the real estate purchase is no longer considered probable. If the Company intends to terminate a purchase agreement, it records a charge to earnings for the costs associated with the purchase agreement in the period such a decision is made. This expense is included as a component of cost of sales – homes in the unaudited condensed consolidated statements of income and totaled $0.5 million and $0.6 million for the three months ended August 31, 2020 and 2019, respectively.

(i) Property and equipment

Property and equipment is recorded at cost. Depreciation and amortization is generally recorded using the straight-line method over the estimated useful lives of the assets, which range from two to five years. Depreciable lives for leasehold improvements reflect the lesser of the economic life of the asset or the term of the lease. Repairs and maintenance costs are expensed as incurred. The Company’s property and equipment at August 31, 2020 and May 31, 2020 consisted of the following (in thousands):

August 31,2020

May 31,2020

Office furniture and equipment $ 3,844 $ 3,852 Sales offices, design studios, and model furnishings 33,487 32,863 Leasehold improvements 2,438 2,414

39,769 39,129 Accumulated depreciation and amortization(1) (29,102) (27,912)

$ 10,667 $ 11,217 (1) Net of retirements and disposals.

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Depreciation and amortization expense approximated $2.2 million and $2.4 million for the three months ended August 31, 2020 and 2019, respectively.

(j) Revenue recognition

With respect to home sale revenues, revenue from a home sale is recognized when we have satisfied the performance obligation in the home sales contract, which is generally at the time of the closing of each sale, when title to and possession of the property are transferred to the buyer. The revenue recognized for each home sale includes the base sales price of the home, as well as any purchased options and upgrades and is reduced for any sales price incentives. Our performance obligation to deliver the agreed-upon home is generally satisfied in less than one year from the original contract date. Home sale contract assets consist of cash from home closings in transit or held in escrow for our benefit, which is typically received within two days of the home closing. Home sale contract assets totaled $4.8 million and $6.4 million at August 31, 2020 and May 31, 2020, respectively, and are classified as receivables in the unaudited condensed consolidated balance sheets. Home sale contract liabilities include customer deposit liabilities related to sold but undelivered homes, which totaled $23.7 million and $17.6 million at August 31, 2020 and May 31, 2020, respectively. Of the customer deposit liabilities at May 31, 2020, $8.6 million was recognized in revenues in the three months ended August 31, 2020 upon the closing of the related homes. Also included in home sale revenues are our wholesale home sales within our Starlight Homes brand. Wholesale home sales primarily consist of completed homes sold under bulk sales agreements to real estate investors who intend to use the homes as rental properties. See Note 1(l) for additional discussion of warranties and obligations associated with home sales revenue.

With respect to land sale revenues, we periodically elect to sell parcels of land or lots. These land and lot sales are generally outright sales of specified land parcels with cash consideration due on the closing date, which is generally when performance obligations are satisfied. Land sale contract assets consist of cash from closed land sales in transit or held in escrow for our benefit, which is typically received within two days of closing on the land sale. Land sale contract assets are classified as receivables in the unaudited condensed consolidated balance sheets. Land sale contract liabilities consist of customer deposit liabilities related to land parcels under contract for sale. There were no land sale contract assets or liabilities at August 31, 2020 and May 31, 2020.

With respect to financial services and other revenues, financial services revenues, which are not within the scope of ASC 606, primarily consist of title premium income earned from the provision of title services for homebuyers. Other revenues consists of revenue from forfeited customer deposits that is recognized upon cancellation of the home sales contract when the Company is contractually entitled to retain the deposit and other miscellaneous customer revenue that is recognized when the related performance obligation is satisfied. Other revenues also include revenue from fee development, development oversight, and/or construction agreements entered into by the Company with third-party property owners. For these types of contracts, the Company recognizes revenue based on the actual total costs it has incurred plus the applicable fee. In accordance with ASC 606, the Company applies the percentage-of-completion method, using the cost-to-cost approach, as it most accurately measures the progress of our efforts in satisfying our obligations within the fee building agreements. Under this approach, revenue is earned in proportion to total costs incurred divided by total costs expected to be incurred. In the course of providing fee development, development oversight, and/or construction services, the Company routinely subcontracts for services and incurs other direct costs. These costs are typically passed through to the property owners and, in accordance with GAAP, are included in the Company’s financial services and other revenues and cost of sales financial services and other revenues on the consolidated statements of income.

ASC 606 provides certain practical expedients that limit some accounting treatments and disclosure requirements. Accordingly, we do not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less. In addition, the expected revenue to be recognized in any future year relating to unsatisfied performance obligations with an original expected length greater than one year is not material.

(k) Prepaid expenses

Included in other assets are prepaid expenses of approximately $8.8 million and $8.9 million as of August 31, 2020 and May 31, 2020, respectively, which primarily represent prepaid insurance, fees, permits, and rent.

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(l) Warranty costs

The Company provides its homebuyers with limited warranties that generally provide for ten years of structural coverage, two years of coverage for plumbing, electrical and heating, ventilation and air conditioning systems, and one year of coverage for workmanship and materials. Warranty liabilities are initially established on a per home basis by charging cost of sales and establishing a warranty liability for each home delivered to cover expected costs of materials and labor during the warranty period. The amounts accrued are based on management's estimate of expected warranty-related costs under all unexpired warranty obligation periods. The Company's warranty liability is based upon historical warranty cost experience in each operating division and is adjusted as appropriate to reflect qualitative risks associated with the types of homes built and the geographic areas in which they are built. The Company's warranty liability is included in other liabilities in the unaudited condensed consolidated balance sheets.

Presented below are summaries of the activity in the Company’s warranty liability account for the three months ended August 31, 2020 and 2019 (in thousands):


2020 2019Warranty liability, beginning of period $ 10,122 $ 11,933

Costs accrued during period 2,989 2,548 Costs incurred during period (2,943) (3,788)

Warranty liability, end of period $ 10,168 $ 10,693

(m) Advertising costs

The Company expenses advertising costs as they are incurred. Advertising expense, which is included in selling, general and administrative expenses in the unaudited condensed consolidated statements of income, was approximately $1.6 million and $3.6 million for the three months ended August 31, 2020 and 2019, respectively.

(n) Long-term incentive plan

The Company offers a long-term incentive compensation program designed to align the interests of the Company and its executives by enabling key employees to participate in the Company’s future growth through the issuance of performance shares, which are the equivalent of phantom equity awards. The Company's performance shares are accounted for pursuant to ASC Subtopic 710-10-25-9 to 25-11, Deferred Compensation Arrangements, as the value is not based on the shares of a comparable set of public builders or other equity instruments, but is based on the book value of equity of the Company. The Company measures the value of the performance shares on a quarterly basis using the intrinsic value method. Additional compensation expense may be recognized subsequent to completion of the vesting period for appreciation-only performance shares. See Note 10 for additional discussion regarding the Company’s long-term incentive plan.

(o) Income taxes

The Company operates as a limited liability company and is treated as a partnership for income tax purposes. Accordingly, the Company incurs no liability for federal or state income taxes, since the taxable income or loss is passed through to its Members, but incurs liabilities for certain state taxes payable directly by the Company. The Company calculates its Members’ potential tax liability related to their share of the Company’s taxable income and may make distributions to such Members to allow them to satisfy their tax liability, subject to limitations contained in the Company’s senior secured revolving credit facility and in the indentures governing its 6.750% Senior Notes due 2025 (the “6.750% Notes”), its 9.875% Senior Notes due 2027 (the “9.875% Notes”), and its 6.625% Senior Notes due 2028 (the “6.625% Notes”). Any tax distributions made to the Members are treated as a reduction of equity. The Company made tax distributions to its Members of $4.0 million and $7.0 million during the three months ended August 31, 2020 and 2019, respectively.

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(p) Use of estimates

The preparation of unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

(q) Segments

ASC Subtopic 280, Segment Reporting (“ASC 280”) provides standards for the way in which companies report information about operating segments. In accordance with ASC 280, the Company believes that each of its homebuilding operating markets is an operating segment. In accordance with the aggregation criteria defined in ASC 280, the Company has grouped its homebuilding operations into two reportable segments as follows:

1) East: Raleigh, Charleston, Atlanta, Orlando, and Southwest Florida (Tampa, Sarasota, and Naples)2) Central: Houston, Dallas, Austin, San Antonio, and Phoenix

The Company has determined that the homebuilding operating markets within its respective reportable segments have similar economic characteristics and product types, and are similar in terms of geography. The Company’s homebuilding operating markets also share all other relevant aggregation characteristics prescribed in ASC 280, such as similar product types, production processes and methods of distribution. See Note 13 for further discussion of the Company’s reportable segments.

(r) Risks and uncertainties

The worldwide spread of COVID-19 virus has caused broad business and social disruption across many industries and locations, both domestically and abroad. Further, the spread of COVID-19 has also caused significant volatility in U.S. and international debt and equity markets. To date, COVID-19 has caused significant negative impacts across our industry, from trade availability, increases in the cost of certain building materials, suspension of services in local municipalities, delays in homes closings, increased cancellations, various and differing shelter in place orders by state, county, and other local municipalities, and disruptions to normal operating procedures, to volatile economic conditions and a decline in consumer confidence. There is significant uncertainty around the breadth, severity, and duration of COVID-19 and the business disruptions related to COVID-19, as well as its impact on the U.S. and international economies, consumer confidence and, in turn, the impact it will have on our results.

(s) Subsequent events

The Company has evaluated subsequent events through October 13, 2020. This date represents the date on which the consolidated financial statements were available to be issued.

On October 13, 2020, the Board of Directors of the Company approved tax distributions of $9.6 million to its Members based on estimates of its Members' tax liability related to their share of the Company's taxable income.

Note 2 — Pending and Recently Adopted Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which changes the impairment model for most financial assets and certain other instruments from an “incurred loss” approach to a new “expected credit loss” methodology. The effective date of ASU 2016-13 was amended by the release of ASU 2019-10 in November 2019 and was extended to fiscal years beginning after December 15, 2022, and for annual and interim periods thereafter. The standard requires an entity to recognize the effects of adopting the new standard as a cumulative effect adjustment to opening retained earnings in the period of adoption. The Company is currently evaluating the impact that adoption of ASU 2016-13 will have on its condensed consolidated financial statements and related disclosures.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (“ASU 2020-04”), which provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (LIBOR) or by another reference

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rate expected to be discontinued. ASU 2020-04 is effective beginning March 12, 2020 and can be applied prospectively through December 31, 2022. The Company has not elected to apply any of the expedients or exceptions of ASU 2020-04 to date and is currently evaluating the impact the guidance under ASU 2020-04 may have on its condensed consolidated financial statements and related disclosures in future periods.

Note 3 — Inventory

Inventory consisted of the following at August 31, 2020 and May 31, 2020 (in thousands):

August 31,2020

May 31,2020

Homes under construction and finished homes $ 547,517 $ 545,079 Finished lots 239,991 215,419 Land under development 90,828 86,964 Land held for future development 20,814 28,231 Land held for sale 6,018 6,309

$ 905,168 $ 882,002

The Company capitalizes all interest incurred to the extent its qualifying assets meet or exceed its debt obligations. If qualifying assets are less than the Company’s debt obligations, there are limits on the amount of interest that can be capitalized, and the remainder of interest incurred must be directly expensed. The Company directly expensed interest of $7.4 million and $2.8 million for the three months ended August 31, 2020 and 2019, respectively, in the unaudited condensed consolidated statements of income.

The following table summarizes interest costs incurred, charged to cost of sales and directly expensed during the three months ended August 31, 2020 and 2019 (in thousands):


2020 2019Capitalized interest, beginning of period $ 21,646 $ 19,040

Interest incurred 15,974 12,963 Interest amortized to cost of sales (9,003) (8,743) Interest expensed (7,429) (2,776)

Capitalized interest, end of period $ 21,188 $ 20,484

Note 4 — Other Assets

Other assets at August 31, 2020 and May 31, 2020 consisted of the following (in thousands):

August 31,2020

May 31,2020

Real estate not owned $ 83,971 $ 79,738 Right-of-use assets(1) 12,125 13,121 Prepaid expenses 8,815 8,885 Architecture plans 4,483 4,626 Deferred financing fees 2,550 2,725 Pre-acquisition costs 6,531 7,161 Other deposits 2,008 2,117

$ 120,483 $ 118,373 (1) See Note 12, Leases, for additional information.

In the ordinary course of business, the Company enters into lot purchase agreements in order to procure lots for the construction of homes in the future. Pursuant to these lot purchase agreements, the Company generally will

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provide a deposit to the seller as consideration for the right, but not the obligation, to purchase lots at different times in the future, usually at predetermined prices. Depending on the circumstances of such lot purchase agreements, “Real estate not owned” may be recorded based on the application of different accounting provisions in accordance with ASC 810 or ASC 470-40. In applying these provisions, the Company regularly evaluates its land and lot purchase agreements.

Pursuant to ASC 810, when the Company enters into a purchase agreement to acquire land or lots from an entity and pays a non-refundable deposit, the Company has concluded that a variable interest entity (“VIE”), for which consolidation is required, may be created because it is deemed to have provided subordinated financial support that will absorb some or all of an entity’s expected losses if they occur. For each VIE, the Company assesses whether it is the primary beneficiary of the VIE and thus must consolidate the entity by first determining if it has the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract; and the ability to change or amend the existing purchase contract with the VIE. If the Company is determined not to control such activities, it is not considered the primary beneficiary of the VIE. If it does have the ability to control such activities, it will continue the analysis by determining if it is expected to absorb a potentially significant amount of the VIE’s losses or, if no party absorbs the majority of such losses, if it will benefit from potentially a significant amount of the VIE’s expected gain. If the Company determines that it is the primary beneficiary of the VIE, it will consolidate the VIE in its financial statements and reflect such assets as “Real estate not owned” and the related liabilities as “Liabilities related to real estate not owned.” At August 31, 2020 and May 31, 2020, no purchase contracts or investments in unconsolidated entities were determined to require consolidation under ASC 810.

Pursuant to ASC 470-40, if a buying entity participates in an arrangement in which it is economically compelled to purchase land, then the entity is required to consolidate such an arrangement. From time to time, the Company enters into arrangements in which it identifies lots that it desires to purchase, finds an investor to purchase the lots and then enters into option purchase agreements to acquire the lots in staged takedowns. In consideration for such options, the Company generally makes nonrefundable deposits. While the Company is generally not obligated to purchase the lots that are the subject of such agreements, it would forfeit the remaining deposits if the lots are not purchased. Although the Company is not obligated to purchase the lots under option unless it enters into a contract with specific performance obligations, if, at the reporting date, the Company believes that due to the terms of the purchase contracts it is compelled to purchase the lots under option, the Company will record “Real estate not owned” and the related liabilities as “Liabilities related to real estate not owned” in connection with such option purchase agreements. The Company has one lot purchase agreement with an unaffiliated investor group that is accounted for pursuant to ASC 470-40. At August 31, 2020 and May 31, 2020, the Company recorded real estate not owned of $23.9 million and $24.9 million, respectively, related to the lot purchase agreement accounted for pursuant to ASC 470-40.

Also, based on the provisions of ASC Subtopic 606-10, Revenue From Contracts With Customers, a seller may not recognize as a sale property it sells if an entity has an obligation or a right to repurchase lots and if the repurchase agreement is considered to be a financing arrangement. ASC 606 considers a repurchase option contract to be a financing arrangement, in accordance with ASC 606-10-55-70, if the entity will repurchase the lots for an amount that is equal to or greater than the original selling price of the asset. Therefore, if the Company enters into lot purchase option agreements for land it has sold and determines that the repurchase agreement is considered to be a financing arrangement, the Company records the lots subject to such sale as “Real estate not owned” and the related liabilities, under option agreement, as “Liabilities related to real estate not owned.” At August 31, 2020 and May 31, 2020, the Company recorded real estate not owned of $60.1 million and $54.9 million, respectively, for the sale of lots because its repurchase agreements related to this real estate were considered to be financing arrangements. While these option agreements contain no specific performance obligations, should the Company choose not to purchase the land, it will forfeit the deposited amount.

Architecture plans are comprised of the costs incurred related to architecture plans, associated engineering costs, and interactive floor plans for house plans, and are amortized through cost of sales on a per closing basis.

Deferred financing fees included in other assets are comprised of costs incurred in connection with obtaining financing under the senior secured revolving credit facility. The Company incurred deferred financing fees of $51.0

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thousand and $1.7 million during the three months ended August 31, 2020 and 2019, respectively, as a result of the amendment to the Company's senior secured revolving credit facility as discussed below in Note 6.

See Note 1(h) for additional information on pre-acquisition costs.

Note 5 — Investments in Unconsolidated Entities

The Company enters into land joint ventures from time to time as a means of accessing larger parcels of land and lot positions, managing its risk profile and leveraging its capital base. As of August 31, 2020, the Company had an equity investment in one land joint venture with an affiliate of certain of the beneficial owners of the Company's equity or their affiliates (individually and collectively, the “Investors”). The Company has a 49% limited partner interest in this joint venture, does not have a controlling interest in this unconsolidated entity, and has accounted for it under the equity method. The Company has entered into a lot purchase agreement with the joint venture that permits but does not require the Company to purchase finished lots owned by the land joint venture. Lot prices are generally negotiated prices that approximate fair value when the purchase contract is signed. The Company’s share of the unconsolidated entity’s earnings on the sale of lots to the Company is deferred until homes related to the lots purchased by the Company are delivered and title passes to a homebuyer. The partners generally share profits and losses in accordance with their ownership interests. As of August 31, 2020, the Company had recorded $1.1 million for its investment in this unconsolidated entity in the unaudited condensed consolidated balance sheets. The Company has also entered into a services agreement with the joint venture to provide accounting and administrative services to the joint venture. The Company receives a monthly fee of $6.0 thousand for these services that is included in other income in the unaudited condensed consolidated statements of income. The Company is a party to a lot purchase agreement with the joint venture, which required a 10% deposit, and has no specific performance requirements for the Company. As of August 31, 2020, the total purchase price of lots remaining to be purchased under this agreement was approximately $14.5 million. As of August 31, 2020, the joint venture had $4.8 million of debt outstanding, which is non-recourse to the joint venture and to the Company. The loan was obtained to fund land development for one phase of the property. The Company provided the lender with a performance guarantee for the substantial completion of this phase of development. The guarantee of performance may include the payment of money for costs incurred during the completion of the development. In the event the Company pays money or performs any services pursuant to the guarantee, the joint venture has agreed to indemnify and reimburse the Company for any such costs incurred.

The Company offers residential mortgage services to its homebuyers and the public at large in Austin, Dallas, Houston, San Antonio, Charleston, Raleigh, Orlando, Phoenix, and Southwest Florida through an unconsolidated mortgage joint venture. The Company has an ownership interest of 49% in this mortgage joint venture. The Company’s investment in this mortgage joint venture is accounted for under the equity method. The debt of the mortgage joint venture is non-recourse to the Company.

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Summarized unaudited financial information related to unconsolidated entities that are accounted for using the equity method as of August 31, 2020 and May 31, 2020 and for the three months ended August 31, 2020 and 2019 was as follows (in thousands):

August 31,2020

May 31,2020

Assets: Cash $ 4,473 $ 5,650 Mortgage notes receivable 31,096 54,472 Real estate 9,728 9,384 Other 910 713

Total assets $ 46,207 $ 70,219

Liabilities and equity:Liabilities:

Accounts payable and other accruals $ 4,277 $ 5,274 Notes payable (1) 34,917 55,643

Total liabilities 39,194 60,917 Equity 7,013 9,302

Total liabilities and equity $ 46,207 $ 70,219 (1) The notes payable balance at August 31, 2020 is comprised of $30.1 million outstanding on two warehouse lines and $4.8

million of secured debt, all of which is non-recourse to the Company. The notes payable balance at May 31, 2020 is comprised of $52.0 million outstanding on two warehouse lines and $3.7 million of secured debt, all of which is non-recourse to the Company.


2020 2019Revenues:

Lot sales $ — $ 2,977 Financial services 5,599 3,641

Total revenues 5,599 6,618

Gross profit 3,491 2,887

General and administrative expenses:Financial services 785 675

Total general and administrative expenses 785 675

Net earnings $ 2,707 $ 2,212

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Note 6 — Debt

Debt at August 31, 2020 and May 31, 2020 consisted of the following (in thousands):

August 31,2020

May 31,2020

6.750% Notes (1) $ 247,054 $ 246,878 9.875% Notes (2) 249,434 249,182 6.625% Notes (3) 245,788 245,610 Note payable 4,025 4,725

$ 746,301 $ 746,395 (1) Net of $2.9 million and $3.1 million of unamortized deferred financing costs as of August 31, 2020 and May 31, 2020,

respectively.(2) Net of $4.0 million and $4.2 million of unamortized deferred financing costs and $1.6 million of unamortized discount as of

both August 31, 2020 and May 31, 2020.(3) Net of $4.2 million and $4.4 million of unamortized deferred financing costs as of August 31, 2020 and May 31, 2020,

respectively.

The 6.750% Notes

On August 8, 2017, the Company issued $250 million principal amount of 6.750% Senior Notes due 2025 (the “6.750% Notes”) in a private offering pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The 6.750% Notes were issued at a price of 100.00% of the principal amount to yield 6.750%.

The 6.750% Notes mature on August 1, 2025. Interest is payable on February 1 and August 1 of each year. The 6.750% Notes are senior, unsecured obligations of the Company and rank equally in right of payment to all of the Company’s existing and future senior debt and senior in right of payment to all the Company’s existing and future subordinated debt. The 6.750% Notes are effectively subordinated to any of the Company’s existing and future secured debt, including the senior secured revolving credit facility, to the extent of the value of the assets securing such debt. The obligations under the 6.750% Notes are jointly and severally guaranteed by each Restricted Subsidiary, as defined, other than certain Restricted Subsidiaries that have assets with a book value of less than $2.0 million. All of the Company's subsidiaries are Restricted Subsidiaries with respect to the 6.750% Notes, with the exception of AW Mortgage Holdings L.L.C., which has been designated an Unrestricted Subsidiary pursuant to the indenture governing the 6.750% Notes.

The Company has the option to redeem the 6.750% Notes at any time or from time to time, in whole or in part, (a) from August 1, 2020 until August 1, 2023, at certain redemption prices set forth in the indenture governing the 6.750% Notes together with accrued and unpaid interest thereon, if any, to and excluding the redemption date, and (b) on or after August 1, 2023, at 100% of the principal amount to be redeemed, together with accrued and unpaid interest thereon, if any, to and excluding the redemption date.

The indenture governing the 6.750% Notes contains a number of covenants, including covenants relating to the following:

• Limitations on indebtedness;• Limitations on restricted payments;• Limitations on dividends;• Limitations on transactions with affiliates;• Limitations on liens;• Limitations on asset sales;• Limitations on designation of unrestricted subsidiaries; and• Limitations on mergers.

As of August 31, 2020, the Company was in compliance with the covenants in the indenture governing the 6.750% Notes.

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The 9.875% Notes

On March 27, 2019, the Company issued $255.0 million principal amount of 9.875% Senior Notes due 2027 (the “9.875% Notes”) in a private offering pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The 9.875% Notes were issued at a price of 99.301% of the principal amount to yield 10.000%.

The 9.875% Notes mature on April 1, 2027. Interest is payable on the 9.875% Notes on April 1 and October 1 of each year. The 9.875% Notes are senior, unsecured obligations of the Company and rank equally in right of payment to all of the Company’s existing and future senior debt and senior in right of payment to the Company’s existing and future subordinated debt. The 9.875% Notes are effectively subordinated to any of the Company’s existing and future secured debt, including the Company's senior secured revolving credit facility, to the extent of the value of the assets securing such debt. The obligations under the 9.875% Notes are jointly and severally guaranteed by each Restricted Subsidiary, as defined, other than certain Restricted Subsidiaries that have assets with a book value of less than $2.0 million. All of the Company's subsidiaries are Restricted Subsidiaries with respect to the 9.875% Notes, with the exception of AW Mortgage Holdings L.L.C., which has been designated an Unrestricted Subsidiary pursuant to the indenture governing the 9.875% Notes.

The indenture governing the 9.875% Notes gives the Company the option to redeem the 9.875% Notes at any time or from time to time, in whole or in part, (a) until April 1, 2022, at a redemption price equal to 100% of their principal amount, together with accrued and unpaid interest thereon, if any, to and excluding the redemption date, plus an applicable premium as defined in the indenture governing the 9.875% Notes, (b) on or after April 1, 2022 until April 1, 2025, at certain redemption prices set forth in the indenture governing the 9.875% Notes together with accrued and unpaid interest thereon, if any, to and excluding the redemption date, and (c) on or after April 1, 2025, at 100% of the principal amount to be redeemed, together with accrued and unpaid interest thereon, if any, to and excluding the redemption date.




The 6.625% Notes

On January 23, 2020, the Company issued $250.0 million principal amount of 6.625% Senior Notes due 2028 (the “6.625% Notes”) in a private offering pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The 6.625% Notes were issued at a price of 100.00% of the principal amount to yield 6.625%.

The 6.625% Notes mature on January 15, 2028. Interest is payable on the 6.625% Notes on January 15 and July 15 of each year. The 6.625% Notes are senior, unsecured obligations of the Company and rank equally in right of payment to all of the Company’s existing and future senior debt and senior in right of payment to the Company’s existing and future subordinated debt. The 6.625% Notes are effectively subordinated to any of the Company’s existing and future secured debt, including the Company's senior secured revolving credit facility, to the extent of the value of the assets securing such debt. The obligations under the 6.625% Notes are jointly and severally guaranteed by each Restricted Subsidiary, as defined, other than certain Restricted Subsidiaries that have assets with a book value of less than $2.0 million. All of the Company's subsidiaries are Restricted Subsidiaries with respect to the 6.625% Notes, with the exception of AW Mortgage Holdings L.L.C., which has been designated an Unrestricted Subsidiary pursuant to the indenture governing the 6.625% Notes.

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The indenture governing the 6.625% Notes gives the Company the option to redeem the 6.625% Notes at any time or from time to time, in whole or in part, (a) until January 15, 2023, at a redemption price equal to 100% of their principal amount, together with accrued and unpaid interest thereon, if any, to and excluding the redemption date, plus an applicable premium as defined in the indenture governing the 6.625% Notes, (b) on or after January 15, 2023 until January 15, 2026, at certain redemption prices set forth in the indenture governing the 6.625% Notes together with accrued and unpaid interest thereon, if any, to and excluding the redemption date, and (c) on or after January 15, 2026, at 100% of the principal amount to be redeemed, together with accrued and unpaid interest thereon, if any, to and excluding the redemption date.




Senior Secured Revolving Credit Facility

On August 28, 2019, the Company amended its senior secured revolving credit facility by entering into its Second Amendment to the Fifth Amended and Restated Credit Agreement (as amended, the “Restated Revolver”), providing for, among other things, (i) an aggregate revolving loan commitment of up to $350.0 million with up to $50.0 million available for the issuance of letters of credit and a $20.0 million swingline facility, and with an accordion feature to permit the size of the facility to be increased in the future up to $420.0 million (dependent upon Company needs and available lender commitments), (ii) a maturity date of August 28, 2023, and (iii) modification of certain covenants and restating the agreement to reflect such changes. The Restated Revolver limits the principal amount of the aggregate commitment available at any time to the amount that is permitted by the indentures governing the Company's 6.750% Notes, 9.875% Notes, and 6.625% Notes, which is 30% of Consolidated Tangible Assets, as defined therein.

Interest accrues on borrowings under the Restated Revolver at the London Interbank Offered Rate (LIBOR) plus an applicable margin that ranges from 275 to 335 basis points. Letters of credit may be issued under the Restated Revolver at a rate of 100 basis points if secured by cash, or at a rate of 275 to 335 basis points if not secured by cash. The Restated Revolver has a maturity date of August 28, 2023, subject to an extension in accordance with the terms set forth therein. The Restated Revolver is secured by a continuing first priority security interest in the real property of certain operating divisions selected by the Company for inclusion in the borrowing base, and the personal property of the Company and its subsidiaries affixed to, placed upon, used in connection with, arising from or appropriated for use on the pledged real property and the continuing guarantee of substantially all of its subsidiaries. The Company may pledge additional collateral as needed to increase the borrowing base consistent with the maximum availability under the Restated Revolver.

The Restated Revolver contains the following material financial covenants:

• A minimum level of Tangible Net Worth;• A maximum Leverage Ratio;• A minimum Interest Coverage Ratio;• Minimum liquidity;• Maximum level of land supply; and • Maximum level of Speculative Housing Units and Model Housing Units.

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Availability under the Restated Revolver is based upon a borrowing base formula. The Restated Revolver contains other affirmative and negative covenants in addition to the financial covenants noted above. The Restated Revolver permits sales and transfers of ownership interests in the Company so long as no change of control, as defined in the Restated Revolver, occurs, permits certain tax distributions to Members and permits certain other distributions to Members if certain Leverage Ratio and other conditions are met. As of August 31, 2020, the Company was in compliance with the covenants in the Restated Revolver.

At August 31, 2020, there were no borrowings outstanding under the Restated Revolver and $0.8 million of letters of credit outstanding. As of August 31, 2020, the Company had available additional borrowing capacity of $247.2 million under the Restated Revolver based on outstanding borrowings on the Restated Revolver, outstanding letters of credit, the value of collateral pledged to secure the facility, and the borrowing base formula.

Note Payable

On December 13, 2019, the Company issued a $4.7 million note payable to an unaffiliated third party, related to a purchase of land, which matures on July 13, 2022. The note payable has an interest rate of 10.00%. The note is collateralized by the land to which it relates and has no recourse to any other assets or to the Company. As of August 31, 2020, the outstanding note payable balance, including accrued interest, totaled $4.0 million.

Note 7 — Other Liabilities

Other liabilities at August 31, 2020 and May 31, 2020 consisted of the following (in thousands):

August 31,2020

May 31,2020

Liabilities related to real estate not owned (1) $ 54,312 $ 55,210 Salaries, bonuses, and benefits 15,761 35,080 Lease liabilities(2) 13,656 14,410 Accrued interest 14,037 15,718 Warranty accruals 10,168 10,122 Accrued long-term compensation 10,867 12,674 Accrued real estate taxes 6,453 4,027 Other 21,855 20,134

$ 147,109 $ 167,375 (1) Net of deposits of $29.7 million and $23.3 million in August 31, 2020 and May 31, 2020, respectively.(2) See Note 12, Leases, for additional information.

Note 8 — Members’ Equity, Amended Regulations, and Ownership

The Second Amended and Restated Regulations (as amended, the “Regulations”) of the Company created three classes of members and associated membership interests as follows: (1) Class A Membership Interest, which is held by Little Shots Nevada, L.L.C. (“Little Shots”), (2) Class B Membership Interests initially issued to the holders of our former 11.0% Senior Subordinated Notes due 2015, the majority of which are now held by Little Shots, and (3) Class C Membership Interests created in June 2010, the majority of which are held by Little Shots. The Regulations set forth each Member’s respective membership interests and sharing ratio. No Member is required to make any additional contributions to the Company. Subject to certain limited exceptions, including for tax distributions, all items of income, gain, loss, deduction and credit of Ashton Woods will be allocated among the Members in accordance with their sharing ratios.

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At August 31, 2020, there were 20,628,729 membership interests outstanding, comprised as follows:

Membership Interests

Ownership percentage

Percentage of membership class

Little Shots Nevada L.L.C.Class A 8,027,200 38.91 % 100.00 %Class B 1,922,151 9.32 % 97.43 %Class C 8,167,244 39.59 % 76.84 %

Total Little Shots Nevada L.L.C. 18,116,595 87.82 %

Various HoldersClass B 50,649 0.25 % 2.57 %Class C 2,461,485 11.93 % 23.16 %

20,628,729 100.00 %

Note 9 — Transactions with Related Parties

Services agreement

The Company is a party to a services agreement with the Investors that provides the Company with a license, as well as development and support, for certain of the Company’s computer systems and administrative services. The Company pays a fee of $800 per home closing quarterly, in arrears, for these services, which is included in selling, general and administrative expenses in the unaudited condensed consolidated statements of income. The Company incurred fees of $1.0 million and $0.2 million during the three months ended August 31, 2020 and 2019, respectively, under the services agreement. As of August 31, 2020 and May 31, 2020, the balance due to the Investors under the terms of the service agreement was $1.0 million and $1.4 million, respectively, and was included in other liabilities in the unaudited condensed consolidated balance sheets.

Lease

The Company is a party to a lease as a lessee with the Investors to rent approximately 8,500 square feet of commercial space in Dallas, Texas. The Company has 28 months remaining on the lease as of August 31, 2020. Total minimum lease payments due under the lease were $0.3 million as of both August 31, 2020 and May 31, 2020.

Lot purchase agreements

The Company is a party to nine lot purchase agreements with the Investors. A deposit ranging from 10% to 20% was required under each of the purchase agreements, and there are no specific performance requirements for the Company. The Company is required to record one of these lot purchase agreements as real estate not owned in the unaudited condensed consolidated balance sheets. As of August 31, 2020, the total purchase price of lots remaining to be purchased under such agreements was approximately $50.3 million.

Joint venture

The Company is a party to a land joint venture with the Investors, which is accounted for under the equity method. The Company has an equity investment of less than 50% in the joint venture and does not have a controlling interest in the unconsolidated entity. Also, the Company is a party to a lot purchase agreement with the joint venture to purchase 130 lots. A 10% deposit was required under the purchase agreement and there are no specific performance requirements for the Company. As of August 31, 2020, the total purchase price of lots remaining to be purchased was $14.5 million. As of August 31, 2020, the joint venture had $4.8 million of debt outstanding, which is non-recourse to the joint venture and to the Company. The loan was obtained to fund land development for one phase of the property. The Company provided the lender with a performance guarantee for the substantial completion of this phase of development. The guarantee of performance may include the payment of money for costs incurred during the completion of the development. In the event the Company pays money or

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performs any services pursuant to the guarantee, the joint venture has agreed to indemnify and reimburse the Company for any such costs incurred.

Note 10 — Long-Term Incentive Plan

In July 2012, the Board of Directors adopted the Ashton Woods USA L.L.C. 2013 Performance Share Plan (the “2013 Plan”), a long-term incentive compensation program designed to align the interests of the Company and its executives by enabling key employees to participate in the Company’s future growth. In July 2013, the Board of Directors adopted the Amended and Restated Performance Share Plan (the “First Amended Plan”), and in July 2016, the Board of Directors adopted the Second Amended and Restated Performance Share Plan, with an effective date of June 1, 2016 (the “Second Amended Plan”) (together with the 2013 Plan and the First Amended Plan, the “Plan”). The Plan provides for the grant to participants of full-value performance shares and appreciation-only performance shares, which are the equivalent of phantom equity awards. Full-value performance shares allow the participant to receive a cash payment equal to the total value of the performance share on the designated date of payment. Appreciation-only performance shares allow the participant to receive a cash payment equal to the increase in value of the performance share measured from the date of grant to the designated date of payment. In each July of 2013 through 2020, the Board of Directors awarded outstanding performance shares to the Company’s executive officers, and certain officers and members of the corporate and operating division senior management teams.

The value of a performance share under the Second Amended Plan is determined by dividing the Company's book value, as defined under the Plan, by the number of hypothetical shares as defined by the Plan. Generally, except as determined by the Board upon grant, performance shares awarded under the Plan will vest ratably over three years and will be subject to forfeiture upon the occurrence of certain events, including termination of employment for cause. The performance shares will become fully vested upon a participant’s resignation for good reason, the participant’s death or disability or a change of control, and with respect to certain grants upon an equity sale, as defined in the Plan. In the absence of a payment event otherwise defined in the Plan, the full-value performance share awards pay out after the third anniversary of the award date, and the appreciation-only performance share awards pay out after the fifth anniversary of the award date.

The following table represents a rollforward of the outstanding performance shares for the three months ended August 31, 2020:

Full-value shares

Appreciation-only shares

Total shares

Outstanding performance shares as of May 31, 2020 239,633 703,922 943,555 Performance shares awarded during the period 119,274 238,548 357,822 Shares forfeited during the period — — — Fully vested performance shares paid (74,388) (82,559) (156,947)

Total outstanding performance shares as of August 31, 2020 284,519 859,911 1,144,430

Total vested performance shares as of August 31, 2020 106,113 503,103 609,216

The Company has elected to account for performance shares awarded under the Plan using the intrinsic value method. The Company’s liability for performance shares awarded under the Plan is remeasured quarterly to reflect the intrinsic value of the performance shares awarded as of the balance sheet date. As a result, the Company may record an increase or decrease in compensation expense in any period. Compensation expense for the full-value and appreciation-only performance shares is included in selling, general and administrative expenses in the unaudited condensed consolidated statements of income.

The total number of performance shares vested as of August 31, 2020 and May 31, 2020 was 609,216 and 695,110, respectively. The Company recorded $1.8 million and $1.0 million for the three months ended August 31, 2020 and 2019, respectively, in compensation expense associated with the full-value and appreciation-only performance shares. For the three months ended August 31, 2020 and 2019, $3.6 million (156,947 units) and $2.9 million (142,240 units), respectively, of vested performance shares were paid out to employees. As of August 31, 2020 and May 31, 2020, the Company’s liability for the performance shares was $10.9 million and $12.7 million, respectively, which is recorded in other liabilities in the unaudited condensed consolidated balance sheets.

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Note 11 — Fair Value Disclosures

ASC Subtopic 820, Fair Value Measurement, defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This standard establishes a three-level hierarchy for fair value measurements based upon the significant inputs used to determine fair value. Observable inputs are those that are obtained from market participants external to the Company while unobservable inputs are generally developed internally, utilizing management’s estimates, assumptions and specific knowledge of the assets/liabilities and related markets. The three levels are defined as follows:

• Level 1: Valuation is based on quoted prices in active markets for identical assets and liabilities. • Level 2: Valuation is determined from quoted prices for similar assets or liabilities in active markets,

quoted prices for identical or similar instruments in markets that are not active, or by model-based techniques in which all significant inputs are observable in the market.

• Level 3: Valuation is derived from model-based techniques in which at least one significant input is unobservable and based on the Company’s own estimates about the assumptions that market participants would use to value the asset or liability.

The carrying amounts of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, customer deposits, notes payable, and the Restated Revolver, as reported in the accompanying unaudited condensed consolidated balance sheets, approximate their fair values due to their short-term maturity or floating interest rate terms, as applicable. The factors considered in determining fair values of the Company’s communities when necessary under ASC 360 are described in the discussion of the Company’s inventory impairment analysis (see Note 1), and are classified as Level 2 or Level 3 valuations. The following table summarizes ranges for the significant quantitative unobservable inputs we utilized in our fair value measurements with respect to the inventory impairments recorded during the periods presented:

Unobservable Inputs:Three months ended

August 31, 2020Average selling price $300,000 - $847,000Annual discount rate 12%

The following table presents the carrying amounts and estimated fair values of the Company’s 6.750% Notes, 9.875% Notes, and 6.625% Notes at August 31, 2020 and May 31, 2020:

August 31, 2020 May 31, 2020Fair Value Hierarchy

Carrying Amount Fair Value

Carrying Amount Fair Value

Liabilities: (in thousands)6.750% Notes Level 2 $ 247,054 $ 252,500 $ 246,878 $ 237,500 9.875% Notes Level 2 249,434 280,500 249,182 263,288 6.625% Notes Level 2 245,788 251,250 245,610 226,875

$ 742,276 $ 784,250 $ 741,670 $ 727,663

The Company's 6.750% Notes, 9.875% Notes, and 6.625% Notes are recorded at their carrying values in the unaudited condensed consolidated balance sheets, which may differ from their respective fair values. The carrying values of the Company's 6.750% Notes, 9.875% Notes, and 6.625% Notes reflect their face amount, adjusted for any unamortized debt issuance costs and discount. The fair values of the 6.750% Notes, 9.875% Notes, and 6.625% Notes are derived from quoted market prices by independent dealers (Level 2).

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Note 12 — Commitments and Contingencies

The Company is involved in lawsuits and other contingencies in the ordinary course of business. The amounts demanded by the claimants in these lawsuits and claims may vary widely, with large demands made in certain cases, which are disputed and aggressively defended by the Company. The Company establishes liabilities for legal claims and related matters when such matters are both probable of occurring and any potential loss is reasonably estimable. The Company accrues for such matters based on the facts and circumstances specific to each matter and revise these estimates as the matters evolve. In such cases, there may exist an exposure to loss in excess of any amounts currently accrued. In view of the inherent difficulty of predicting the outcome of these legal and related matters, we generally cannot predict the ultimate resolution of the pending matters, the related timing, or the eventual loss. While the outcome of such contingencies cannot be predicted with certainty, we do not believe that the resolution of such matters will have a material adverse effect on the Company’s results of operations, financial condition, or cash flows. However, to the extent the liability arising from the ultimate resolution of any matter exceeds the estimates reflected in the recorded reserves relating to such matter, we could incur additional charges that could be significant.

The Company has entered into employment agreements with its executive officers and certain other employees that provide for severance payments based on salary and the most recent bonus paid or target bonus upon termination without cause, or, with respect to certain of these officers, following a change of control, by the Company without cause or by the executive for good reason.

In the normal course of business, the Company provides letters of credit and surety bonds to third parties to secure performance and provide deposits under various contracts and commitments. At August 31, 2020 and May 31, 2020, the Company had letters of credit outstanding of $0.8 million and $2.7 million, respectively, and surety bonds outstanding of $81.3 million and $73.6 million, respectively. As of August 31, 2020, the Company had $49.2 million of unused letter of credit capacity under the Restated Revolver.

The Company enters into various option purchase agreements to acquire land. In connection with such agreements, as of August 31, 2020, the Company has made nonrefundable deposits of $180.5 million, which includes $29.7 million of nonrefundable deposits related to purchase and option agreements recorded under ASC 606 or ASC 470-40 (See Note 4). The Company would forfeit the remaining deposits if the lots are not purchased. The total purchase price of lots remaining to be purchased under option agreements with nonrefundable deposits was approximately $1.3 billion as of August 31, 2020.

Leases

The Company leases office space and equipment under various operating leases with varying commencement dates and renewal options for use in our operations. We recognize lease expense for these leases on a straight-line basis over the lease term and combine lease and non-lease components for all leases. Right-of-use assets and Lease liabilities are recorded on the unaudited condensed consolidated balance sheets for all leases with an expected term of at least one year. Some leases include one or more options to renew. The exercise of lease renewal options is generally at our discretion. The depreciable lives of right-of-use assets and leasehold improvements are limited to the expected lease term. Our lease agreements do not contain any residual value guarantees or material restrictive covenants.

Right-of-use assets are classified within other assets on the unaudited condensed consolidated balance sheets, while Lease liabilities are classified within other liabilities on the unaudited condensed consolidated balance sheets. Right-of-use assets and Lease liabilities were $12.1 million and $13.7 million at August 31, 2020, respectively, and $13.1 million and $14.4 million at May 31, 2020, respectively. During the three months ended August 31, 2020, there was $0.1 million of additions to the right-of-use assets under operating leases. There were no additions to the right-of-use assets under operating leases during the three months ended August 31, 2019. Payments on Lease liabilities during both the three months ended August 31, 2020 and 2019 totaled $0.9 million.

Lease expense includes costs for leases with terms in excess of one year as well as short-term leases with terms of less than one year. For the three months ended August 31, 2020 and 2019 our total lease expense approximated $1.3 million and $1.5 million, respectively, inclusive of short-term lease costs. Sublease income, short-term lease costs, and variable lease costs are not material to the unaudited condensed consolidated financial statements.

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The future minimum lease payments required under our leases as of August 31, 2020 are as follows (in thousands):

Year ending May 31, 2021 $ 2,374 Year ending May 31, 2022 3,496 Year ending May 31, 2023 3,140 Year ending May 31, 2024 2,261 Year ending May 31, 2025 2,106 Thereafter 4,677 Total future minimum lease payments(a) 18,054 Less: Interest (b)(c) 4,398 Total future minimum lease payments less interest(c) $ 13,656 (a) Lease payments include options to extend lease terms that are reasonably certain of being exercised. (b) Our leases do not provide a readily determinable implicit rate. Therefore, we estimate our discount rate for such leases

to determine the present value of lease payments at the lease commencement date.(c) The weighted average lease term and weighted average discount rate used in calculating our Lease liabilities were 4.6

years and 7.8%, respectively, at August 31, 2020.

Note 13 — Information on Segments

The Company’s homebuilding reportable segments are as follows:

1) East: Raleigh, Charleston, Atlanta, Orlando, and Southwest Florida (Tampa, Sarasota, and Naples)2) Central: Houston, Dallas, Austin, San Antonio, and Phoenix

The following table summarizes revenue, gross profit, depreciation and amortization, equity in earnings in unconsolidated entities, and net income for each of the Company’s reportable segments (in thousands):


Revenues: 2020 2019 Homebuilding: East $ 203,141 $ 186,626 Central 210,685 176,808

Total homebuilding revenues 413,826 363,434 Land sales 65 — Financial services and other revenue 9,591 6,735

Total revenues $ 423,482 $ 370,169 Gross profit (1): Homebuilding: East $ 32,419 $ 26,021 Central 46,121 32,237

Total homebuilding gross profit 78,540 58,258 Land sales gross profit (9) (28) Financial services and other revenue gross profit 2,388 2,328

Total gross profit $ 80,919 $ 60,558

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Depreciation and amortization: East $ 871 $ 1,075 Central 1,283 1,260

Total depreciation and amortization $ 2,154 $ 2,335 Equity in earnings of unconsolidated entities: East $ 316 $ 94 Central 1,183 874

Total equity in earnings of unconsolidated entities $ 1,499 $ 968 Net income (loss): East $ 3,672 $ (741) Central 18,732 6,528

22,404 5,787 Other (2) (4,654) (2,624) Total net income $ 17,750 $ 3,163

(1) Includes inventory impairments on homes totaling $0.3 million for the east segment during the three months ended August 31, 2019, and $24.6 thousand and $41.0 thousand for the central segment during the three months ended August 31, 2020 and 2019, respectively. There were no inventory impairments on homes for the east segment during the three months ended August 31, 2020.

(2) “Other” primarily consists of interest directly expensed. The following table summarizes total assets for each of the Company’s reportable segments (in thousands):

August 31,2020

May 31,2020

Assets: Homebuilding: East $ 616,369 $ 644,009 Central 599,265 537,735

1,215,634 1,181,744 Other (1) 258,774 270,501 Total assets $ 1,474,408 $ 1,452,245

(1) “Other” is comprised of cash, restricted cash, and corporate assets.

The following table summarizes additions to property and equipment for each of the Company’s reportable segments for the periods presented (in thousands):


2020 2019Additions to property and equipment: Homebuilding: East $ 447 $ 791 Central 1,273 1,489

1,720 2,280 Other (1) 12 —

Total additions to property and equipment $ 1,732 $ 2,280

(1) “Other” is comprised of property and equipment additions for the Company's corporate office.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following management’s discussion and analysis is intended to assist the reader in understanding the Company’s business and is provided as a supplement to, and should be read in conjunction with, the Company’s unaudited condensed consolidated financial statements and accompanying notes included elsewhere in this quarterly report and with our annual report on Form 10-K for the fiscal year ended May 31, 2020. The Company’s results of operations discussed below are presented in conformity with U.S. GAAP.

Forward-Looking Statements

Certain statements included in this report contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, which represent our expectations or beliefs concerning future events, and no assurance can be given that the results described in this report will be achieved. These forward-looking statements can generally be identified by the use of statements that include words such as “estimate,” “project,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “foresee,” “likely,” “will,” “target,” “could,” “seek”, or other similar words or phrases. All forward-looking statements are based upon information available to us as of the date of this report.

A forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update or revise any forward-looking statement, to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events or new information, even if future events make it clear that any expected results that we have expressed or implied will not be realized. Though we are of the view that such forward-looking statements are reasonable, the results or savings or benefits in the forward-looking statement may not be achieved. New factors emerge from time to time and it is not possible for management to predict all such factors.

These forward-looking statements reflect our best estimates and are subject to risks, uncertainties, and other factors, many of which are outside of our control, which could cause

NOT FILED WITH THE SEC 10-Q... · 2020. 10. 13. · not filed with the sec this quarterly report is...

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